Elliott nudges GKN toward Melrose, but price must be right

22 January 2018 11:56am
Thames bend in river

16 January 2018. By James Pressley.

When Paul Singer’s Elliott disclosed an interest in GKN yesterday, the hedge fund appeared to be gate-crashing an unsolicited bid from Melrose Industries for the UK producer of aerospace and automotive parts.

But looks can be deceptive.

Elliott is understood to agree with investors who are urging the Airbus and Boeing supplier to open discussions with Melrose, a London company that specializes in acquiring troubled companies and turning them around.

Whether the fund thinks Melrose’s offer price is right is another matter altogether.

‘Opportunistic’

Elliott has now disclosed a 1.7 percent interest in GKN acquired through “contracts for difference” — derivatives through which an investor and a CfD provider agree to pay each other the change in the price of the underlying stock when the contract ends.

The disclosure came after GKN rejected Melrose’s stock-and-cash offer of 7 billion pounds ($9.6 billion) and announced it would split in two instead of accepting an “entirely opportunistic” bid that undervalued the company.

But Elliott is understood to have been accumulating the GKN position for some time, reflecting its methodical research. By the time the fund takes a stake in a company, its analysts have combed through its balance sheet and picked over its profit margins.

Elliott also reported a 0.7 percent short position in Melrose. That represents a hedge on its GKN investment, not skepticism about the buyer, it is understood.

Melrose has a track record for buying companies, improving their performance and selling them for a higher price — as it reported doing when it sold utility-meter maker Elster to Honeywell International and returned more than 2 billion pounds to shareholders.

Weakened target

GKN is a natural target for both Melrose and Elliott. The company has what some investors consider first-rate technology and “world-performing” companies in its portfolio, but it’s hobbled by what Melrose calls a “conglomerate-like structure” and “below par shareholder returns.”

GKN has missed its own margin targets and underperformed MSCI indexes for the aerospace and auto-parts industries. The company itself initiated an internal review last year, saying that “both profit margins and cash generation have been below expectations.” Then accounting errors at an aerospace plant in Alabama triggered profit warnings and the departure of “CEO designate” Kevin Cummings.

The top job has now gone to Anne Stevens, a non-executive director and former Ford Motor executive who turned around the carmaker’s operations in Canada, Mexico and South America, GKN says.

But given GKN’s tarnished past, many investors doubt the company can transform itself. Though the plan to split in two makes some sense, GKN should still engage in talks with Melrose, they say.

And then there’s the question of price.

Habit of intervention

Like many hedge funds, Elliott has a history of intervening in takeovers and getting buyers to increase their bids. Exhibit A is Bain Capital and Cinven’s agreement in September to offer Elliott and other minority investors a higher price for their shares in German generic drugmaker Stada.

More recently, Elliott has pressed Qualcomm to raise the price of $110 a share it agreed to pay for NXP Semiconductors more than a year ago, telling fellow investors that the Dutch chipmaker was worth $135 a share.  

The practice of buying into a takeover target and seeking to bump up the price is sometimes called “bumpitrage.” But the pejorative term assumes that the offer price is “full and fair,” as Qualcomm has insisted with NXP.

What if the acquirer is out to buy valuable assets at bargain prices? Is that “cheapotrage”? The whole point of activist investing is to unlock value for shareholders — not to hand it over to an acquirer who pounces when a company is down on its luck.

This article was prepared for an upcoming MLex news service covering activist investments. Complete the form below to register your interest.